The Total Addressable Market Size

How to Calculate and Examples for Business Plans and Startups

 

Determining "TAM" - Total Addressable Market Size for a Startup and Why it Matters

How much is the magic market share number? It depends on how much the investment ask is: you don't need a $20 billion market share to make a profit; niche companies often succeed with much small shares–they just succeed on a smaller scale.

In this section, we'll cover some basic ways you, as the angel investor, can estimate the addressable market share. We'll also talk about how to drill down in a startup's pitch deck, what to look for when the startup talks market share, and how to protect yourself against poor investments with regard to market.

Back-of-the-Napkin Considerations

You can do some back-of-the-napkin math to estimate a startup's future share of the market. The more you know about the industry or product type in question, the more accurate your math is likely to be, which is one reason many angel investors choose to operate in fields with which they have experience.

For a solid estimate of TAM, you'll need five pieces of information.

1.  The total population of potential users

This may be a geographical consideration: There are 100,000 people in the city where a restaurant wants to launch. More likely, this is a more abstract number, since the majority of angel investors are opting for opportunities in Internet, software, e–commerce and other virtual spaces. A total possible population for a mobile app launching in the United States, for example, might be up to 182 million people in 2015, according to Statista's numbers on smartphone users in the nation. The site also forecasts smartphone user population to grow to 220 million in 2018.

2.  Definition of the market segment and estimated percent of target customers.

Your product limits the percent of your market segment. Angel investors should ask: Who is this product for? Who is likely to want, need, and purchase this product? Are people already buying similar products, and if so, who are those people?

Consider an app that acts as a virtual storybook for babies. The obvious market for such an app would be new parents with smartphones. There are a total of 318 million people in the US; if 182 million have smartphones, then approximately 57 percent of the population has a smartphone. There are around 4 million babies born each year—applying some dirty math, we can assume that 57 percent, or around 2.28 million, of those babies have at least one parent with a smartphone. That's the target audience for our app.

This back-of-the-napkin math is rough: the population numbers used to arrive at the above percentages counted young children and older individuals, which are less likely to own smartphones. Child–bearing parents are more likely to own the devices, which means the target audience could be as high as 3 million. For ease of estimation, let's assume 2.5 million. Out of 182 million smartphone users, that's approximately 1.4 percent.

3.  How many of the products will be purchased at a time?

If a company is selling software through licenses, businesses can purchase multiple instances of the product. Someone with a hot new cupcake recipe is going to sell in multiples as well; our baby app, however, is most likely going to sell one to each user.

4.  How often will the product be purchased?

Does the product lend itself to repeat purchase? Is it a commodity or necessity that will be used up, so consumers must refill or restock? At first glance, a software product is going to be purchased once for each user, but what about new versions and upgrades? Are those free, or monetized?

5.  What is the intended selling price of the product?

We'll look at two possibilities with our baby app example. First, the startup may charge for its app.  Given app store prices, and depending on how much functionality the startup is going to provide in its app, price might range from 99 cents to $7.99. For the example, assume the startup charges $2.99.

The other possibility is that that startup offers the app free to users, but plans to monetize it through ads, in–app purchases, or professional relationships. In this case, the angel investor needs to see the startup's projections on how much per user the app might generate. For our example, let's assume the startup estimates $5 in revenue per user, per year.

 

Possible Market Share Formula

The basic market share formula multiplies all of the data points above. So, for our baby app, basing market share solely on the purchase price of $2.99, maximum market share would be:

182 million smartphone users * 1.4 percent target audience * 1 purchase at a time * 1 purchase (no repeats) * $2.99

The maximum potential market share would be approximately $7,618,520 per year.

Drilling Down: The Startup's Pitch Deck

That $7.6 million market share number for our imaginary baby app is unrealistic, but some startups are optimistic enough to publish such numbers in their pitch deck. No matter how great the product and timing is, you aren't going to get 100 percent to buy–in from your potential market, and remember, the math we did to get to $7.6 million was all estimates and quick Internet statistics searches. You have to assume the numbers are off a bit.

 

Startups tend to make sweeping statements about market targets in their pitch deck. They might state, "We're targeting 1 percent of a $20 billion market by 2022." As the angel investor, you have to do your own math, as shown above, to vet the total market claim, and then you have to evaluate whether you think the startup is on point with their target. How likely is the 1 percent goal? At Angel Kings, we like to see startups that provide more specific market definitions, even if that reduces opportunities to $500 million instead of $20 billion.

 

Is the Startup's Plan Backed by Verifiable Data?

Startups with specific market definitions have some data to back up claims; as the angel investor, you should vet that data against your own research or knowledge of the market. The statistics we used to create our assumptions for the baby app market share are an example of data that anyone can vet. Startups should source such information, but a quick online search turns up information too. You should also download the app yourself, try it out, and see if people would care enough to pay for it.

 

It's harder to decipher the percent of potential market a startup hopes to obtain. Ask how the startup came up with that percent. Did they conduct market surveys? Are they basing the data on comparable products? The startup launching our imaginary baby app might have polled 500 new mothers and mothers–to–be to find out if they would be interested in purchasing an app, and then applied that data to the overall market to determine that 20 percent of possible consumers would make a purchase.

 

Despite how much data the startup presents, you as the angel investor have to make a judgment call. Do you buy in to the market assumptions the startup makes? Do you think they are probably too optimistic? Even if the startup's assumptions are too optimistic, does the market share potential you see make the investment worthy?    

 

Tomorrow's Market, not Today's

As an investor, you are worried more about tomorrow's market than today's market. Understanding today's market lets you make evaluations of future market potential. In some industries, you can also use benchmarks, expert guidance on industry trends, and forecasts to estimate future market behavior. With our baby app example, an investor might use the estimated smartphone user growth from several statistical sites to gauge how much the potential market will grow.

 

Primary Demand vs. Secondary Demand

Numbers and data are important, but investors must also understand the difference between primary and secondary demands. Primary demand references the market size for a specific product or product category–baby apps, cupcakes, virtual hard drives, and point–of–sale software, for example.

Secondary demand refers to the size of the market for a brand.

About startups, market size and demand for products.  

About startups, market size and demand for products.  

When dealing with early–stage startups in most industries, angel investors are concerned with primary demand because fledgling startups often tout a single product idea. While concentrating on primary demand, keep secondary demand in mind as it plays a role in growth potential. What are the brand goals and plans for the startup? Will the startup pull its audience through branding more so than product, and does the startup plan to branch out with products that could capture greater shares of the market in the future?

 

In a few niche industries, secondary demand is the primary evaluation point. This might be true when evaluating biotech or social startups, for example, where audiences buy in to an idea is much more important than the product itself.

 

 

 

 

Setting Limitations as an Angel Investor

"Investing in Startups" - How to Guide.

"Investing in Startups" - How to Guide.

You know the saying about going to the grocery store hungry or without a list? Chances are, you walk out spending more than you wanted and with items you don’t need. As an angel investor, enter evaluation phases with limitations in mind to avoid getting caught up with the people and idea and failing to see the potential market pitfalls.

Some angel investors won't consider a startup that doesn't have a potential minimum market share of $500 million or more. Others won't invest in a company where growth projections can't be reasonably estimated at 10 percent a year or more. You shouldn’t set targets and ranges like this.

Even more important than arbitrary limitations is your own awareness of earning potential. No investment is 100 percent safe, but by calculating market share, the angel investor has a better understanding of the type of returns that can be expected if the startup is successful.

 

 

 

 

 

 

The Total Addressable Market Size and Startups - Transcript from Startup Expert

I've been pitched by numerous startups that claim that the audience is a 50 billion dollar market. They claim that they are going to have 10% of that market. As a startup looking for evaluation or looking for the right business model, you've got to be careful in what's called the Total Addressable Market (TAM). 

Find out how big/large the market is for your product, startup, and business plan? Venture capital expert and investor, Ross Blankenship (http://rossblankenship.com) describes the "total" addressable market (TAM), how to calculate market size, and how large or big your product or service idea should be before launching your company.

You have to make sure that you don't think you're going to get that percentage of a pie that might expand. It could contract depending on the markets' supply and demand. Be careful with those numbers and don't just say, it's a 100 billion dollar market. We're going to have a percentage of it. A business plan is not going to tell you what percentage of that market you're going to have. The Total Addressable Market formula should be thought of like a pie chart. You have the number of people in a potential population that would be interested or buy your product. You have the lifetime value, meaning the number of times somebody would buy it in general. In our book, Kings Over Aces, the Total Addressable market is a formula that we refer to.

If you're doing a baby pregnancy app and you're trying to figure out the number of potential users for that app, so that you can figure out how to monetize it. You start with the number of women each year who deliver or have kids, then find out how many would download your app. Then you have to determine how much to charge for the app, how many people would buy it, and how many kids would a average woman have. That's sort of a general construct of what's called the Total Addressable Market and if people have questions about the market size before they write out their formula take a look at our book. 

 

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